Fertilizers May Be the EPA's Latest Victim

Proposed changes to the Renewable Fuel Standard established by the Environmental Protection Agency call for a cut in ethanol production, which could have a cascading effect on nitrogen fertilizer companies.

Feb 5, 2014 at 1:10PM

Worldwide, fertilizer companies are anticipating growth to meet the food demands of a growing population. Domestically, fertilizer companies may be looking to Washington to see what they can expect in terms of growth. Nitrogen-based fertilizer companies like Agrium (NYSE:AGU), PotashCorp (NYSE:POT), and Rentech Nitrogen Partners (NYSE:RNF) stand to benefit from the use of corn-based ethanol as a fuel due to the corresponding increase in fertilizer needed to grow corn versus other crops.

What does Washington have to do with fertilizer?
The nation's largest ethanol producers are not the only ones hoping that the Environmental Protection Agency's (EPA's) proposed modifications to the Renewable Fuel Standard (RFS) do not take hold as the comment period for the proposed standards came to a close last week. Renewable fuel producers and bipartisan politicians from ethanol-producing states were among the list of opponents to the proposed revisions, which call for a 3 billion gallon cut to the volume of ethanol produced as compared to what the law could currently mandate.

A reduction in the amount of ethanol produced in the U.S. would not only affect the ethanol industry. One of the strongest arguments among those opposing ethanol is that food-based crops should not be used for fuel production. This one issue is part of the reason why ethanol production impacts so many other industries, including livestock farmers and major food producers who purchase corn as a primary feedstock or processing ingredient. Though the claims of how much corn prices have increased since the RFS was originally established in 2005 are at times highly exaggerated, there has been a very direct and measurable increase in corn prices since the program was implemented. The yearly average price of corn roughly tripled over the last eight years, though it should be likewise noted that the yearly average prices of soybeans and wheat also more than doubled over the same duration.

While livestock farmers, food producers, and arguably consumers have suffered the economic consequences of higher corn prices, the increase in the price of corn is a direct aid to nitrogen-based fertilizer companies. Regardless of the extent of the corn price increases, farmers have recognized corn as a valuable cash crop, and accordingly the acreage devoted to corn in the U.S. dramatically increased after the RFS was established. Though arguments could be made that corn demand grew outside of its use for ethanol production, the fact remains that around 40% of the corn harvest in certain years has been devoted to fuel production. Increased corn planting leads to an increased demand in crop nutrients, and companies like Agrium and PotashCorp capitalize on providing supply for the growing demand.

Magnitude of the RFS impact
Corn crop yields have been increasing along with the amount of land planted with corn, and part of that is attributable to increased fertilizing of the crop fields. Corn is a nitrogen-dependent plant, and nearly all corn planted requires added nitrogen regardless of its use. It is difficult to project just how great the impact of declining ethanol production would be on corn prices and acreage of corn planted, but the effects would be far from negligible.

A very conservative estimate that 30% of the yearly corn harvest goes toward fuel production combined with the proposed 18% decrease in the amount of ethanol to be used for domestic fuel supplies amounts to a 6% decrease in overall corn production based solely on likely decreases in ethanol production. Whether a 6% decrease in corn acreage planted will actually occur is yet to be realized, but if ethanol production volumes are cut, there will inevitably be a decrease in corn demand. Decreased demand equates to decreased prices. Decreased corn prices equate to fewer farmers deciding to grow corn, and less corn being planted equates to less demand for nitrogen-based fertilizers.

A balancing act for fertilizers
Is a decrease in ethanol production enough to cause trouble for fertilizer companies moving forward? Like all industries, rarely can one cause be to blame for a company's eventual success or failure. Investors need to look at all of the biggest variables affecting nitrogen fertilizer producers, and determine if domestic issues of ethanol-related difficulties and increasing natural gas expenses are enough to overshadow a slow but steadily increasing global demand for fertilizers.

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Shamus Funk has no position in any stocks mentioned. The Motley Fool owns shares of PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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